Earnest Money and Escrow Accounts
Earnest money is common to every transaction as it acts as a good faith sum of money that is put down to bind the purchase contract. When an offer is made to purchase real estate, it is usually accompanied by an “earnest money deposit”. This is a check from the buyer that serves as a deposit showing the intent to purchase the property. The amount of the earnest money deposit will vary from one deal to the next dependent upon a variety of factors. Sometimes a buyer will put a larger earnest money deposit down if there is other interest in the property. The general rule of thumb is that an earnest money deposit should not exceed 2 percent of the purchase price. State rules and local customs will also help in determining the amount of the earnest money deposit. Note that the earnest money deposit is not necessarily a form of down payment though.
An earnest money deposit is always made to a real estate brokerage, escrow or title company, or a legal firm. The third party is responsible for depositing the money in a separately maintained trust fund account. A receipt of the earnest money should always be obtained from whomever the earnest money deposit is given to.
It’s important to note that as a real estate professional you need to advise your clients about how earnest money works and any inherent risks involved. Once a buyer and seller agree to the purchase contract, then the earnest money deposit is placed into a trust account. It is then no longer the buyer’s money as it now belongs to both the buyer and seller. If a deal falls through, the buyer and seller must both agree to the way the earnest money funds will be dispersed. Laws also vary from state to state in terms of if the earnest money is refundable upon the cancelation of the contract and the acceptable timeline for the refund to be made.
A neutral third party handles the escrow of a property. An escrow account is utilized to protect all parties involved in the transaction. The distribution of funds is handled by the escrow agent so that it is completed in a fair manner and all necessary parties involved in the transaction are included. Commissions and taxes are also handled through the escrow account.
There are a number of escrow companies to choose from in most markets ranging from national brands to local names, a buyer, seller or real estate agent can determine what company to use for escrow.
While escrow accounts may not affect you directly as a real estate professional, it is important to understand what an escrow account is and how it works. An escrow account is set up by a lender in order to collect monies that will pay for insurance premiums such as homeowner’s and flood insurance, property taxes, and monthly mortgage insurance premiums should that apply. A homeowner pays a monthly mortgage payment that also has the escrow funds attached to it in order to ensure that the bills connected to the property are paid on time and in full. An escrow account is not always required by a lender, but it is often recommended so that the large payments don’t have to be budgeted for separately.